Friday 22nd September 2000
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|BILL WILSON: 'We were the American Express franchise, we were selling appliances, we were selling cars, you name it'|
Once the country's biggest and most powerful company, Fletcher Challenge is being broken up. In the first of a two-part series, NBR business editor NICK STRIDE talks to key participants about what went wrong
Dismantling a dynasty is a thankless task. The Fletcher Challenge Ltd directors assembled before shareholders on July 4 to sell off the Paper division probably weren't expecting a standing ovation. And they probably weren't surprised when Max Gunn stood up to deliver one of his famed tirades. Gunn roundly accused the whole board of being "wimps" who had "betrayed" the vision of Sir James Fletcher, himself seated in the audience.
Gunn's attack didn't seem to strike much of a chord among the 600-odd shareholders present. A single shout of "shame!" was heard as the resolution to sell Paper to Norway's Norske Skog was passed. And along the directors' table he provoked nothing more than a few weary smiles. Even so, the first step in the breakup of the Fletcher group wasn't exactly an occasion for joy.
"There's a lot of empathy on the board for having these companies New Zealand-based," explains chairman Rod Deane. "But we have to make sure we do the right thing by our shareholders, who've had a fairly hard time over the last decade. Paper will now be part of the second largest player in the world. You might not be inspired by that but that's the reality of the way the world's going."
Gunn may have been right to mourn the end of a vision - that of a world-class New Zealand-based commodities giant - but it's by no means clear whose vision it was. The company formed when Sir James Fletcher's Fletcher Holdings merged with Tasman Pulp & Paper and Challenge Corporation in 1981 was neither multinational nor world-class but it was certainly a conglomerate. It had assets of [$1 billion].
"We were the American Express franchise, we were selling appliances, we were selling cars, you name it," recalls Bill Wilson, a director appointed that year and chairman from 1995 until last year. "But all these businesses were very limited. They came mainly from the Challenge side and we agreed that if we were going to be a major player we had to get into bigger business streams."
Wilson recalls it was Roger Douglas who said New Zealand could be the Switzerland of the South Pacific. "We all believed we could expand."
Getting the three parts to work as one took some years. By 1986 the group's total assets were still a mere $3.9 billion, of which net interest-bearing debt made up 41%. By then chief executive Sir Ronald Trotter and Hugh Fletcher, who took over the top job in 1988, were ready to go. They embarked on a massive expansion, buying building, pulp and paper, and oil and gas assets in New Zealand and around the world. By 1992 the group's assets had risen to $21 billion.
The perception of hindsight is that Fletcher Challenge went on a debt binge and that a hangover was inevitable. But it had been selling as well as buying. The 1992 debt level was $8.4 billion but that was still only 40% of the total.
The problems, according to Hugh Fletcher, arose out of rapid changes in global financial markets. "In 1991 the world capital markets did a complete flip-flop from wanting to lend you as much money as you could possibly take to not wanting to lend to anyone other than somebody who didn't need to borrow," he recalls.
The group sold local assets - Methanex, Wrightson, Rural Bank, two-thirds of NGC, and St Lukes. The sales cut debt to less than $3 billion in just three years. They also cleared the decks for the new structure the group was planning to address a second change in financial markets.
That, according to Fletcher, was "the total destruction of the New Zealand capital base as a source of equity" coupled with "an unbelievable concentration in the asset accumulation business around the world." The group's first big problem, Fletcher says, was how to attract international investors. "They were all industry-focused and none of them were interested in regional conglomerates."
The answer he came up with and took to the board was target shares or "letter stocks." The board agreed. The four divisions were split out as separate companies, each with its own shares. But the assets, and the debt, were held by the group, which allocated a certain proportion of the overall debt to each division.
The idea was that, with discrete businesses that would appeal to investors looking for different characteristics, there would be greater recognition of the value of each division. The prerequisites were that there must be financial, business or cultural synergies for existing under the one umbrella, and that each division must be sound and sustainable in itself.
The board's decision to adopt letter stocks was unanimous. Both Fletcher and Wilson still believe it was the best solution available and both saw it as a permanent structure.
Not all the directors saw it that way. Rod Deane, then a recent recruit to the board, was among those who thought it could only ever be a halfway-house to complete separation. And among investors and financial analysts there was scepticism from the start.
For one thing the group faced the immediate accusation it was protecting itself from takeover. That was always adamantly denied. Fletcher points to a number of letter stock takeovers in the US. Wilson told shareholders on a number of occasions that if anyone made a fair offer for a division's assets the board would consider it.
"We never had one, by the way."
Secondly, Fletcher says, the financial community always doubted the group's claims about synergies. A crucial one was tax. A complete break-up at that time would have resulted in shareholders footing a huge tax bill on the difference between the transaction value and the book value of the assets transferred, the group claimed.
"It's taken a number of years for FCL to find a way around the tax problems," Fletcher says. "And even then it's most robust when there's a third party involved, which is quite different from just splitting yourself into four separate companies."
Third, and most importantly for the group's share price performance, investors worried about the capacity for one letter stock to affect the others. "We recognised the danger that if one division wasn't performing well there would be a contagion for the others," Wilson recalls, "and this is exactly what happened."
What happened was that investors recognised one of the four divisions, Paper, wasn't "sound and sustainable in itself." An Achilles heel had emerged. The group had poured billions into the division in the late 1980s and early 1990s. In 1997 it had $3.3 billion of debt and lost $273 million.
The problem, Wilson says, wasn't on the demand side but in supply. "Normally in resource industries some understanding can be reached but the [paper] industry never could get any agreement on restricting supply. Despite the bad times new large mills kept coming on stream, usually with wider machines which much increased capacity."
The group re-equipped its mills with state-of-the-art machines in the expectation publishers would pay more for better quality paper with less breakdown in the printing room.
"I was always a bit cynical about this because if I buy a Japanese car which goes perfectly I don't pay a premium. In fact, prices dropped as the cars got better. So we never really got the premium we expected," Wilson says.
By the mid-1990s, Fletcher acknowledges, "half the company was in an industry that was destroying value," although only in the northern hemisphere assets, UK Paper and Canada - south of the equator pulp and paper paid its way.
The board began considering an exit from the industry years ago, Fletcher says.
"The controversy was what was the price at which everyone would agree to exit? That was a tortuous process. It took us years before we got an outcome that everyone unanimously agreed on the Fletcher Challenge board."
By then another problem had emerged. In 1996 the group was part of a consortium that paid $2 billion for Forestry Corporation's central North Island forests. The acquisition was financed with a swag of debt and the idea was to fast-track the logging of douglas fir and repay borrowings rapidly. But in mid-1997 Southeast Asian economies went into a tailspin and demand for logs dried up.
Hugh Fletcher stepped down to a non-executive director role and Michael Andrews took over as chief executive. One of his first actions, Deane recalls, was to get out of UK Paper, a feat the group had been trying to accomplish for some time. Andrews then spent a year putting together the deal - Hugh Fletcher's "unanimous answer" to the Paper problem - to merge Fletcher Challenge Canada, which had $1 billion of cash, with the paper division. It was rejected by the Canadian minorities in November last year.
The time for tinkering had run out. A month later a purged and slimmed-down Fletcher Challenge board met and voted to dismantle the Fletcher Challenge group and let the four divisions find their own fates.
Next week: The breakup
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